ackwardation refers to an excess of the expected (future) spot price over the B current futures price.' Contango is the reverse. Previous tests for backwardationhontango, by Houthakker (1957), Rockwell (19671, and others, have studied ex post (realized) returns. In contrast to the previous procedures, this article examines the backwardationlcontango issue by using ex ante implicit expected spot prices from commodity options. This new methodology is explained in some detail following a review of the theory relevant to the subject of backwardation and contango. Empirical results are reported later in the article for one specific commodity: gold.2 *Presented at the December 1981 meetings of the American Economic Association in Washington, DC. 'The term "spot price" in this article refers to the price for immediate delivery. A futures price refers to a price that is negotiated and established in the present, but where the exchange of money and commodity occur at a specified future time. The futures contract is binding on both parties in the sense that neither can cancel the trade. However, in modern futures markets the presence of clearing houses enables either party to liquidate his position prior to the delivery time by a reversing trade. The words "contango" and "backwardation" are employed in a different sense than usual, in that the spotifutures price comparison is based on ezpected spot prices at some point in the future rather than current spot prices.
'Commodity option data are not readily available at present, since commodity options are not currently being traded on organized exchanges. Over-the-counter options on certain metals are traded, but quotations are very time consuming to gather. Consequently, w e limited the data-gathering effort to one commodity and decided to concentrate the article primarily on methodology. Gold was chosen since it is a commodity with a great deal of trading interest and therefore should be traded in an efficient market. Proposals for commodity options are currently being evaluated by various exchanges and regulatory authorities. If and when commodity options become traded, the methodology introduced in this article can he applied more widely.